Page 5 - November-December-CBA-Report

Protecting your clients from unusual second mortgage issues
By Nick Zingarelli
Anyone who has seen a horror movie is familiar with this scenario. A fierce battle ensues between the main char- acters and the antagonist (typically wearing a mask) that results in the slasher’s apparent demise. A few moments of quiet go by before the villain comes back to life for a final battle.
A similar situation has proven to be the case for second mort- gages. As the name suggests, a second mortgage is a loan secured by real estate, but it is in second position to the first mortgage in terms of lien priority. Back in the early 2000s, it was common for homeowners to take out “80/20” mortgages. A lender would loan 80% of the purchase price of the home and a second mortgage would be taken out for the other 20%. This allowed homeowners to sidestep private mortgage insurance (“PMI”). This also led to home purchases with no down payment.
The Great Recession saw real estate values drop to the point where second mortgages no longer attached to any equity in the collateral real estate. For example, let’s assume that a home was purchased for $200,000 in 2007 with an 80/20 loan.1 This would result in a first mortgage for $160,000 and a second mortgage of $40,000. A few years pass and the real estate crash causes the value of the house to drop to $150,000. In this situation, the second mortgage effectively has no value. In fact, a second mortgage can be entirely avoided and paid as a general unsecured creditor2 in a Chapter 13 bankruptcy when it attaches to no equity in the home. If the last payment on the loan comes due during the life of a Chapter 13 bankruptcy, the loan can be bifurcated. More on that later.
When home values plummeted, the second mortgage holder was left with little recourse against the property owner. If the second mortgage holder forecloses, they are only doing the first
mortgage holder’s job for them. If a mortgage creditor success- fully brings a foreclosure action and the property is auctioned through a sheriff’s sale, first priority liens still need to be paid before the second mortgage holder gets any distribution from the sale proceeds.3 As a result, many of these second mortgages appeared to have died over the past decade...or so it would seem!
One of the unforeseen consequences of this real estate market is the reanimation of “zombie” second mortgages. As I mentioned in a recent blog post4, home values reached an all-time high this year. Since home values have increased, second mortgages that were previously valueless may now attach to significant equity in the property. This is especially true if the first mortgage has been paid down through regular monthly payments over the past ten years. A second mortgage that has been unpaid will have accrued significant interest and late fees for non-payment.
I have met with two separate clients this summer who received foreclosure complaints initiated by second mortgage holders. One of these mortgage balances has nearly doubled in size since it was last paid! Additionally, the parties that are filing these foreclosures may look unfamiliar to the homeowner. These second mortgages may have been bought and sold multiple times prior to reaching their final holder.
These second mortgage loans can be very old (at least, old for mortgages). One of the loans that is owed by one of my clients came due in 2019. As I mentioned earlier, a second mortgage that attaches to no equity in a home can be entirely avoided through a Chapter 13 bankruptcy. However, if a loan has fully matured, or if it will mature during the life of a Chapter 13 bankruptcy, it can be modified into secured and unsecured claims.5
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